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Have We Reached a Tipping Point?

4 June 2024

In the lead up to the Bank of Canada’s June 6 meeting, market expectations for a rate cut climbed to around 80 per cent. Initially, analysts were uncertain about the prospect of a cut, but the consensus shifted following a weaker-than-expected first-quarter GDP report.

The Q1 GDP miss is compounded by a downward revision to Q4 2023, which now shows no growth. While the headline GDP figure was lower than expected, the underlying details are somewhat more optimistic. Final domestic demand, a key indicator of domestic activity, grew at its fastest pace in eight quarters. Both business investment and government spending contributions were also up. However, these positive contributions were offset by significant inventory drawdowns, which subtracted nearly 1.5 percentage points from Canada’s GDP in Q1.

This leaves some room for the Bank of Canada to hold off on a rate cut, but economic growth has been much slower than the latest estimates. The central bank had projected 2.8% growth for Q1 and 1.5% for Q2. While the Q2 target is still achievable with April’s estimate at 0.3%, we are starting from a weaker first quarter. Over the past four quarters, growth has averaged just 0.5% year-over-year, nearly 2 percentage points below the estimated potential growth.

The March GDP data revealed declines in real terms for manufacturing, retail, wholesale, and even the public sector saw a slight reduction in activity. The softness also hit goods and services, with both flat for the month. 

The economy is performing well short of its potential, having grown by only 0.5% over the past year. With a widening output gap and a softening job market, the evidence suggests that June is the appropriate time to start cutting rates.

Some commentators are concerned about policy divergence between the Bank of Canada and the Federal Reserve, and how much the Bank can diverge before it affects the stability of the Canadian dollar. However, policy divergence has happened in the past and Governor Tiff Macklem has stressed that the central bank will act independently. I don’t see this being a concern for the Bank – it will let the exchange rate adjust.

Governor Macklem has acknowledged progress on the inflation front but hasn’t provided any explicit signals that a rate cut is coming. This approach is simply prudent communication. The Bank’s Governing Council understands that if there’s a clear indication that rates are going to move lower, the market may preempt the central bank’s actions.

When the Bank does cut rates, don’t expect to see an immediate turnaround in the housing market. We expect the transition towards a more active housing market to occur gradually. Since mid-2022, real estate activity has largely been weak, with sales consistently falling below the 10-year average. Homeowners have been grappling with the highest borrowing costs in years, while would-be buyers have been hesitant to make purchases due to uncertainty surrounding the direction of interest rates. 

A 25-basis point rate cut won’t do much to lower mortgage payments or improve affordability. It might influence buyer sentiment, as consumers have been holding off on entering the housing market until rates show signs of decline. However, any market adjustment will be gradual.

Housing Affordability Watch

CMI monitors the latest developments and offers insights on solutions to Canada’s housing affordability crisis

As the Bank of Canada edges closer to its first rate cut, the real estate market remains in a state of limbo. The trifecta of high prices, high rates, and a severe undersupply of housing has created a perfect storm of unaffordability. Can rising incomes or lower rates make a difference? How effective will the federal government’s housing strategy be? And what systemic changes are necessary to truly address the issue? Read our perspective in the latest Housing Affordability Watch here: What Will End Canada’s Home Affordability Crisis?


Independent Opinion

The views and opinions expressed in this publication are solely and independently those of the author and do not necessarily reflect the views and opinions of any person or organization in any way affiliated with the author including, without limitation, any current or past employers of the author. While reasonable effort was taken to ensure the information and analysis in this publication is accurate, it has been prepared solely for general informational purposes. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author. There are no warranties or representations being provided with respect to the accuracy and completeness of the content in this publication. Nothing in this publication should be construed as providing professional advice including investment advice on the matters discussed. The author does not assume any liability arising from any form of reliance on this publication. Readers are cautioned to always seek independent professional advice from a qualified professional before making any investment decisions.

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